Title

Author

Date of Award

2010

Degree Type

Thesis

Degree Name

Master of Philosophy (MPHIL)

Department

Economics

First Advisor

Dr Jimmy Ran

Second Advisor

Prof Ma Yue

Abstract

This thesis examines the link between exchange rate and unemployment. The unemployment problem in an open economy has mostly been discussed at the micro level. Previous studies focus on job losses from trade by the manufacturing industries. However, the macro level relationship between exchange rate and unemployment has been largely ignored. The aims of this study are twofold. Firstly, a simple theoretical relationship between exchange rate and unemployment is established by the PPP and Phillips curve. The model shows that, under the linked exchange rate system, the unemployment in currency-linked country is a function of the unemployment in the base country, the changes in the exchange rate, the rate of price change differential between the two countries, and the natural rate of unemployment differential between the two countries. By using Hong Kong data, we find that one percent increase in the U.S. unemployment rate transmits 0.53 percent increase in Hong Kong.

Under the floating system, we analyze this problem in the United Kingdom, Germany, and France, which predominantly represent Europe. We investigate the magnitude of the transmitted unemployment and the exchange rate impact among those countries before and after the new currency. We find that the transmission effects are significant, which partially explain the severity of this long-lasting problem. To shed new light, we construct a three-sector model comprising goods market, labor market, and money market. We postulate that domestic product market faces import competition. Thus the exchange rate comes into play, intrinsically affecting the labor demand. In the meantime, we extend the standard money demand function by including both the domestic and foreign money balances. We believe that this extension better reflects the reality. We then solve the general equilibrium model to get the reduced-form solution with our focus on the relationship between exchange rate and employment. We find that the exchange rate effect is unconditional in that home currency depreciation benefits employment and alleviates the unemployment problem.

Copyright

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